The valuation of their trading stock by share dealers – the 2011 amendments to the Income Tax Act

Share dealers – that is to say, persons who trade in shares and whose holdings of shares are consequently trading stock in their hands – fall into two categories, namely individuals and companies.

Share dealers, both individual and corporate, are entitled to deduct losses incurred on the purchase and sale of their shares. Owing to the vagaries of the market, a share dealer may be compelled to report unrealised losses on shares at the end of a financial year in its financial statements, but the loss is only treated as incurred in terms of the Income Tax Act when the shares are actually disposed of.

Valuation at year-end

Since shares in the hands of a share dealer are trading stock, they must (as with every kind of trading stock) be valued at the end of every tax year. The question arises as to whether the shares must be valued at their acquisition cost or at their current market value. In terms of IFRS reporting the shares must be reported at the lower of cost or current market value.

Since time immemorial, corporate share dealers were required by the Income Tax Act to account for their year-end closing stock of shares at historical cost. However, other traded instruments, such as debentures or other interest-bearing instruments, could be reflected at the lower of cost or current market value. In this way unrealised losses on such instruments could be claimed as a deduction before realisation, whereas unrealised gains could be deferred until realisation.

By contrast, individual share dealers could value their closing stock of shares (and other financial instruments) for income tax purposes at the lower of cost or market value, and would invariably choose market value if the instruments had declined in value, so that they could claim the loss in value as an immediate tax deduction.

The amendment to section 22(1)(a)

All this changed with an amendment to section 22(1)(a) of the Income Tax Act that took effect as from tax years commencing on or after 1 January 2011.

As from that juncture, all financial instruments (including shares) thatconstitute trading stock must be brought into account for income tax purposes at cost (irrespective of whether the taxpayer is an individual or a company). Corporate share dealers may no longer claim deduction of unrealised losses on traded instruments other than shares, and individual share dealers are denied the right to claim deduction of unrealised losses on both shares and other traded instruments held as trading stock.

The Commissioner’s power to allow a reduced value of trading stock ‘by reason of damage, deterioration, change of fashion, decrease in market value or for anyother reason satisfactory to the Commissioner’ is explicitly ruled out in relation to financial instruments.

This means that share dealers cannot get a tax deduction until they actually dispose of the financial instruments in question.

Why the change in the rule?

What is the explanation – the reason behind the rule – for this amendment to a long-standing provision in the Income Tax Act?

It would seem that SARS and National Treasury required uniformity in the treatment of instruments traded by share dealers which are held as trading stock. The amendment has therefore achieved uniformity in the treatment of all share dealers as well as uniformity in the treatment of different types of traded instruments.

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